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The primary objectives of the accounting function
in an organization are to process financial
information and to prepare financial statements
at the end of the accounting period. Companies
must systematically process financial information
and must have staff who prepare financial statements
on a monthly, quarterly, and/or annual
basis. To meet these primary objectives, a series
of steps is required. Collectively these steps are
known as the accounting cycle. The steps, applicable
to a manual accounting system, are described
below. Later, there will be a brief discussion of a
computerized processing system.
THE STEPS OF THE CYCLE
1. Collect and analyze data from transactions
and events: As transactions and events related
to financial resources occur, they
are analyzed with respect to their effect
on the financial position of the company.
As an example, consider the sales for a
day in a retail establishment that are collected
on a cash register tape. These sales
become inputs into the accounting system.
Every organization establishes a
chart of accounts that identifies the categories
for recording transactions and
events. The chart of accounts for the retail
establishment mentioned earlier in
this paragraph will include Cash and
Sales.
2. Journalize transactions: After collecting
and analyzing the information obtained
in the first step, the information is entered
in the general journal, which is
called the book of original entry. Journalizing
transactions may be done continually,
but this step can de done in a
batch at the end of the day if data from
similar transactions are being sorted and
collected, on a cash register tape, for example.
At the end of the day, the sales of
$4,000 for cash would be recorded in the
general journal in this form:
Cash 4000
Sales 4000
3. Post to general ledger: The general journal
entries are posted to the general ledger,
which is organized by account. All transactions
for the same account are collected
and summarized; for example, the account
entitled ‘‘Sales’’ will accumulate the
total value of the sales for the period. If
posting were done daily, the ‘‘Sales’’ account
in the ledger would show the total
sales for each day as well as the cumulative
sales for the period to date. Posting
to ledger accounts may be less frequent,
perhaps at the end of each day, at the
end of the week, or possibly even at the
end of the month.
4. Prepare an unadjusted trial balance: At the
end of the period, double-entry accounting
requires that debits and credits recorded
in the general ledger be equal.
Debit and credit merely signify position—
left and right, respectively. Some accounts
normally have debit balances (e.g., assets
and expenses) and other accounts have
credit balances (e.g., liabilities, owners’
equity and revenues). As transactions are
recorded in the general journal and subsequently
posted to the ledger, all
amounts recorded on the debit side of
accounts (i.e., recorded on the left side)
must equal all amounts recorded on the
credit side of accounts (i.e., recorded on
the right side). Preparing an unadjusted
trial balance tests the equality of debits
and credits as recorded in the general
ledger. If unequal amounts of debits and
credits are found in this step, the reason
for the inequality is investigated and corrected
before proceeding to the next step.
Additionally, this unadjusted trial balance
provides the balances of all the accounts
that may require adjustment in the next
step.
5. Prepare adjustments: Period-end adjustments
are required to bring accounts to
their proper balances after considering
transactions and/or events not yet recorded.
Under accrual accounting, revenue
is recorded when earned and expenses
when incurred. Thus, an entry
may be required at the end of the period
to record revenue that has been earned
but not yet recorded on the books. Similarly,
an adjustment may be required to
record an expense that may have been incurred
but not yet recorded.
6. Prepare an adjusted trial balance: As with
an unadjusted trial balance, this step tests
the equality of debits and credits. However,
assets, liabilities, owners’ equity, revenues,
and expenses will now reflect the
adjustments that have been made in the
previous step. If there should be unequal
amounts of debits and credits or if an account
appears to be incorrect, the discrepancy
or error is investigated and corrected.
7. Prepare financial statements: Financial
statements are prepared using the corrected
balances from the adjusted trial
balance. These are one of the primary
outputs of the financial accounting system.
8. Close the accounts: Revenues and expenses
are accumulated and reported by period,
either a monthly, quarterly, or yearly. To
prevent their not being added to or comingled
with revenues and expenses of another
period, they need to be closed
out—that is, given zero balances—at the
end of each period. Their net balances,
which represent the income or loss for
the period, are transferred into owners’
equity. Once revenue and expense accounts
are closed, the only accounts that
have balances are the asset, liability, and
owners’ equity accounts. Their balances
are carried forward to the next period.
9. Prepare a post-closing trial balance: The
purpose of this final step is two-fold: to
determine that all revenue and expense
accounts have been closed properly and
to test the equality of debit and credit
balances of all the balance sheet accounts,
that is, assets, liabilities and owners’ equity.
COMPUTERIZED ACCOUNTING SYSTEM
A computerized accounting system saves a great
deal of time and effort, considerably reduces (if
not eliminates) mathematical errors, and allows
for much more timely information than does a
manual system. In a real-time environment, accounts
are accessed and updated immediately to
reflect activity, thus combining steps 2 and 3 as
discussed in the preceding section. The need to
test for equality of debits and credits through trial
balances is usually not required in a computerized
system accounting since most systems test
for equality of debit and credit amounts as they
are entered. If someone were to attempt to input
data containing an inequality, the system would
not accept the input. Since the computer is programmed
to post amounts to the various accounts
and calculate the new balances as new
entries are made, the possibility of mathematical
error is markedly reduced.
Computers may also be programmed to record
some adjustments automatically at the end of
the period. Most software programs are also able
to prepare the financial statement once it has
been determined the account balances are correct.
The closing process at the end of the period
can also be done automatically by the computer.
Human judgment is still required to analyze
the data for entry into the computer system correctly.
Additionally, the accountant’s knowledge
and judgment are frequently required to determine
the adjustments that are needed at the end
of the reporting period. The mechanics of the
system, however, can easily be handled by the
computer. |
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